What is a cost

In the realm of accounting, the terms «expense» and «cost» are often used interchangeably, leading to confusion.

Defining cost

A cost is essentially an expense recognised based on consumption. This recognition occurs in the period in which a product or service is utilised. Unlike expenses, costs are recorded when the purchased item or service is actively put to use.

Expense vs. cost

To differentiate between an expense and a cost, it’s crucial to understand their timing and application.

When you acquire a product or service, it is termed an expense until the moment you use it. Once consumed, it transforms into a cost. This key difference highlights that buying something is considered an expense, while using it is termed a cost.

Example scenarios

Consider someone who signs up and pays for a seminar three months in advance. The payment is an expense, and after the seminar takes place, it becomes a cost.

Sometimes, the shift from expense to cost happens very quickly, like when you buy lunch for the office. As soon as the lunch is eaten, it shifts from being an expense to being a cost, showing that this change doesn’t necessarily depend on a long period of time.

Application in business

In a business setting, particularly in the production of goods like ice cream, both fixed and variable costs are prevalent. Fixed costs, such as rent and salaries, are predetermined and known in advance. On the other hand, variable costs, like ingredient expenses, may pose challenges in accurate calculation.

For instance, if a company purchases ingredients worth $10,000 in one month but only utilises 75 per cent, the remaining $2,500 is recognised as a cost in the subsequent month.

This underscores the importance of precise accounting practices in reflecting the true financial status of a business.